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Inflation Leads to Slower Auto Sales in China

A cooling economy and an increase in production is forcing dealers to offer discounts and other incentives to keep cars moving

China's appetite for cars has waned, and Zhu Dongwei, an auto salesman in the central Chinese city of Zhengzhou, is doing all he can to revive it. Customers at Zhu's General Motors dealership get a 14 percent discount, a sales tax refund, and a chance to win a free iPod if they buy a 41,800 yuan ($6,170) Matiz compact car. "This is our biggest promotion this year," Zhu said. "Without discounts, many people would wait, not buy."

Wholesale passenger-car deliveries in China grew in June at the slowest pace in 15 months, as rising prices reduced buyers' purchasing power. China's inflation rate that month stood at 2.9 percent, its second-highest level this year. Analysts say demand in the world's largest vehicle market may actually fall in the second half of this year. That would be the first decline in at least 17 months, and it could trigger a price war. "Some dealers and automakers may panic and offer the largest discounts they can," says Yale Zhang, a Shanghai-based analyst at consultant IHS Automotive. "If prices of daily necessities keep soaring, people's expectations of their future financial security will be undermined, reducing their desire to buy a car."

China's auto sales began slowing in April. Besides inflation, China's carmakers have been challenged by an increase in sales tax on small cars to 7.5 percent. It had been halved to 5 percent in 2009, and the cut had helped push up vehicle sales by 46 percent, to 13.6 million units last year, surpassing the U.S. for the first time.

The average price of China's locally made passenger cars fell by 2.08 percent in June from the year before, the biggest decline this year, according to the National Development & Reform Commission. Nonetheless, GM, Volkswagen, Honda Motor (HMC), and Nissan Motor are boosting capacity and introducing new models. Nissan (NSANY), the largest Japanese carmaker in China by sales, aims to expand production by 68 percent, to 900,000 vehicles a year by 2012, with further increases later, Chief Executive Officer Carlos Ghosn said in April. The slowdown in sales growth since April "doesn't affect our plan," says spokeswoman Sharon Shen.

SAIC Motor, China's largest homegrown carmaker and a partner of GM and Volkswagen, said last month it plans to boost capacity by 47 percent, to 1.31 million vehicles annually, by 2012. Kevin Wale, group president of GM China, says the industry has reason to be optimistic. "We had an extraordinary rate of growth last year, so I think it's unfair to talk about a year-to-year negative [growth] rate," said Wale. "We expect the industry to grow at a stable pace through both this year and next year, and from a management perspective, we'll be monitoring inventory levels with our dealers, just to make sure that inventories don't get out of hand."

Still, the industry's expansion carries risk. Domestic auto output exceeded sales by 1.29 million vehicles in the first half of this year, according to the China Automotive Technology & Research Center. The average stockpile period, a measure of the time between when a car is manufactured and its registration, was 55 days in June, compared with 41 days in February, the center says. "Automakers should reduce supply rather than getting into a price war," says Zhao Hang, president of the center.

Such concerns mark a change from early this year, when some customers in Beijing paid a premium of almost $3,000 to skip ahead of a waiting list for Toyota Motor's (TM) RAV4 SUVs, according to Wu Bin, a salesman with Beijing Guangshun Toyota Sales. The dealership stopped charging the premium and cut the vehicle's price in March when sales declined amid global recalls of Toyota models. It is now offering a discount of about $700. "We have to cut prices to keep business going," says Wu.

The bottom line: Demand in China's auto market is cooling even as output is increasing. That has caused dealers to cut prices and offer incentives.